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Glenn Hegar  ·  Texas Comptroller of Public Accounts

Reporting Requirements for Annual Financial Reports of State Agencies and Universities

General Accounting

Specialized Accounting
Fair Value Measurement and Application

GASB 72 (which supersedes or amends parts of 14 existing statements) addresses accounting and financial reporting issues related to fair value measurements with the objective of:

  • Improving financial reporting by clarifying the definition of fair value for financial reporting purposes
  • Establishing general principles for measuring fair value
  • Providing additional fair value application guidance (for example, defining assets and liabilities that can be measured at fair value)
  • Enhancing fair value measurement disclosures

GASB 72 increases consistency, improves comparability and provides more understandable and useful information for financial statement users.

The scope of GASB 72 is limited to:

  • Assets and liabilities that are currently measured at fair value (including derivative instruments)
  • Certain investments not currently measured at fair value

For example, a capital asset currently reported at cost that meets the new definition of an investment is now measured at fair value. The measurement of liabilities at fair value remains limited to liabilities arising in connection with derivatives. GASB 72 generally requires investments to be measured at fair value — with certain exceptions.

Note: These exceptions are the same exceptions that exist under current authoritative standards.

Fair Value

GASB 72 defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is an exit price at the measurement date from the perspective of a market participant that holds the asset or owes the liability (from a seller’s perspective — not a buyer’s). This is a market-based measurement — not an agency specific measurement.

GASB 72 identifies the following three acceptable valuation approaches to determine fair value:

  • Market approach
    Uses prices and other relevant information generated by market transactions involving identical or similar items. Examples include quoted market prices, market multiples technique and matrix pricing technique.
  • Cost approach
    Measures fair value based on the current cost to replace the present service capacity of an asset — taking into account functional (technological) or economic obsolescence as well as physical deterioration. This approach is rarely used.
  • Income approach
    Discounts future amounts (such as cash flows or revenues and expenses) into a single current amount. Types of income approach techniques include:
    • Present value
    • Option pricing model
    • Multi-period excess earnings

Valuation techniques must be applied consistently from period to period. Agencies must use valuation techniques that are appropriate under the circumstances and for which sufficient data is available — maximizing observable inputs and minimizing unobservable inputs.

Fair Value Hierarchy

GASB 72 establishes a fair value hierarchy that classifies inputs to valuation techniques into three levels:

  • Level 1 inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets that the agency can access at the measurement date. Level 1 inputs receive the highest priority.
  • Level 2 inputs are inputs (other than quoted prices included within Level 1) that are observable for an asset or liability — either directly (quoted market prices for similar assets or liabilities) or indirectly (corroborated from observable market information).
  • Level 3 inputs are unobservable inputs for an asset or liability. Level 3 inputs receive the lowest priority.

If fair value is measured using inputs from more than one level, measurement is based on the lowest priority level input significant to the entire measurement. For example, if a measurement has three significant inputs, two are Level 2 and one is Level 3, the fair value measurement is categorized as Level 3 of the fair value hierarchy.

Using quoted prices provided by third parties (such as pricing services or brokers) is permitted if an agency has determined that quoted prices provided by those parties were developed in accordance with the provisions of GASB 72.

Applying the Fair Value Definition to Liabilities

The fair value measurement of a liability assumes it is transferred to a market participant (but not extinguished) at the measurement date. In other words, the fair value measurement assumes an ongoing obligation, not settlement of an obligation. The liability would remain outstanding and the market participant transferee would be required to fulfill the obligation.

For derivatives (such as interest rate swaps), the fair value is not the settlement value provided by the counterparty. Fair value must be measured in accordance with GASB 72 and consider the nonperformance risk of the agency — this includes an agency’s own credit risk in addition to the credit risk of the counterparty. The price received to transfer a liability to a market participant is a better measure of fair value than the amount needed to settle with the counterparty.

Applying the New Investment Definition

GASB 72 defines an investment as a security or other asset that:

  • An agency holds primarily for the purpose of income or profit
  • Has a present service capacity based solely on its ability to generate cash or to be sold to generate cash

An asset is not considered to be an investment if it is part of an agency’s mission/programs. For example, student loans do not qualify as investments because student loans:

  • Are not primarily profit-motivated
  • Provide programmatic benefits

GASB 72 does not change the investments that are measured at fair value — but it does change how fair value is measured. The determination of whether an asset is an investment is based on actions by an agency’s management at acquisition. This classification is retained for financial reporting purposes, even if the agency’s usage of the asset changes over time. For example, an asset that is initially reported as a capital asset and later is held for sale is not reclassified as an investment.

Certain capital assets are exempt from being reported at fair value but are instead measured at acquisition value. The following capital assets are measured at acquisition value beginning in the following fiscal year prospectively:

  • Donated capital assets
  • Donated works of art
  • Historical treasures
  • Capital assets received in service concession arrangements

Agencies must evaluate their assets and determine if they meet the GASB 72 definition of an investment. When applying the definition of investments, the mission of the agency must be considered. If assets meet the definition of an investment, they are reported at fair value (unless specifically exempt). This could result in restatements.

For example, if a building was previously reported as a capital asset but (based on GASB 72) meets the definition of an investment, the building is reported as an investment at fair value along with a restatement. Likewise, if land was previously classified as an investment but (based on GASB 72) it no longer meets the definition of an investment, the land is reported as a capital asset along with a restatement.

Net Asset Value

GASB 72 allows agencies to use net asset value per share (or its equivalent) for an investment in a non-state agency that does not have a readily determined fair value — provided the net asset value is calculated consistent with the Financial Accounting Standards Board’s (FASB) measurement principles for investment companies. Agencies must determine the net asset value per share (or its equivalent) in that manner. The net asset value per share (or its equivalent) is commonly used for certain alternative investments (such as private equity funds and hedge funds).

The net asset value can be used as a practical expedient for the fair value of investments if the net asset value is calculated:

  • As of the agency’s measurement date
  • In a manner consistent with FASB’s measurement principles for investment companies

If the net asset value is not calculated as of the agency’s fiscal year-end, the agency must:

  • Make an adjustment to the net asset value to report fair value as of fiscal year-end
  • Determine if the net asset value is calculated consistent with the measurement principles for investment companies. If it is not:
    • The net asset value provided by the investment company cannot be used
    • The agency is responsible for determining the fair value at fiscal year-end

Equity Interest in Common Stock

GASB 72 eliminates the cost method for investments in common stock. Common stock investments are measured at fair value unless the criteria in GASB 72, paragraphs 205–208, are met for the equity method. GASB expanded the exclusions from the equity method in order to limit the exceptions to fair value measurement. Report equity method holdings that do no meet the definition of investments using the cost method.

Disclosure Requirements

GASB 72 requires disclosures in addition to the existing disclosure requirements (for example, GASB 40 disclosures are still required). Disclosures must be organized by type of asset or liability. Several factors must be taken into consideration when determining the level of detail and disaggregation as well as the amount of emphasis to place on each disclosure requirement. For recurring and nonrecurring fair value measurements, agencies must disclose:

  • Fair value measurement at fiscal year-end
  • Level of fair value hierarchy within which the fair value measurements are categorized in their entirety (level 1, 2 or 3)
  • Description of valuation techniques used in fair value measurement
  • Change in valuation technique that has a significant impact on the result — also disclose the reason for making the change

Additionally, for nonrecurring fair value measurements (for example, impaired capital assets no longer used by an agency), agencies must disclose the reason for the measurement.

Disclosures are also required for investments meeting all of the following criteria:

  • Calculated net asset value per share (or its equivalent) regardless of whether the method of determining fair value in GASB 72, paragraph 71, was applied
  • Do not have a readily determinable fair value
  • Measured at fair value on a recurring or nonrecurring basis during the fiscal year

Disclosures must clarify and explain:

  • The nature and risks of these investments
  • Whether these investments are probable of being sold at amounts different from the net asset value per share (or its equivalent)
  • The investees’ significant investment strategies
  • Any factors that could affect the investments’ liquidity

Investments that are valued at net asset value per share are not subject to the fair value hierarchy and the associated disclosures by level.

Agencies presenting comparative financial statements must present note disclosures for the prior fiscal year in accordance with GASB 72.

For more information on fair value measurement and application, see GASB 72.

Glenn Hegar
Texas Comptroller of Public Accounts
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